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Are We Thinking About Gas Prices Incorrectly?

Prices have risen dramatically, but were they artificially low to begin with?

No one likes to see the price of gas go up. The demand for gas is relatively inelastic, meaning its price can rise substantially without an outsized effect on demand. So it's no surprise that people are disappointed -- and a little ticked off -- that gas prices have gone up more than $2 per gallon in the last several years. Perhaps, though, that's not the best way to think about this issue.

An artificially low base

The chart below helps to illustrate that the lows seen in late 2008 and early 2009 were an aberration, not the norm.

Source: U.S. Energy Information Administration

But let's recall (as if we could forget) what was happening in the economy at that time. Almost everything with a quantifiable price was cratering around us, or approaching multi-year lows. The S&P 500 (SNPINDEX:^GSPC) fell off a cliff, losing nearly half its value in just nine months. A nearly apocalyptic fear brought the price of gas to levels we hadn't seen in years. Unsurprisingly, some of the major players in integrated oil and gas were trading on the cheap, too, in no small part because of the uncertainty in oil and gas futures. On October 10, 2008, for example, Chevron(NYSE:CVX) was trading at what is now its five-year low, and its peers were heavily discounted, as well:

Accounting for dividends, a portfolio investing in equal portions of the above three stocks would have returned 95.8% in the past four years. Keep in mind these are some of the most massive companies in the world. They pay dividends (and pretty good ones, too), they have built-in demand for their product, and their business model is proven and lucrative. And yet, just four years ago, the market thought they were worth about half what they're worth today.

The market can be wrong sometimes. It can gyrate dramatically and overcorrect in times of fear and uncertainty, like during the financial crisis of 2008 to 2009. So we should be careful what we wish for when we pine for those days of $2 gasoline again. In modern times, that price indicates some trouble with the economy. A $2 gallon of gas is nice, but you better hope you're still getting a paycheck to buy it with.